19.5 Evaluating Capital Structure Strategies

2 options to meet capital requirements:

Purchase reinsurance

Impact:

  • Premium \(\downarrow\); Capital Requirement \(\downarrow\)

  • Reserves \(\downarrow\); Capital Requirement \(\downarrow\)

  • Reinsurance Recoverable \(\uparrow\); Capital Requirement \(\uparrow\)

    • Recoverables change is about 25% of the premium and loss reserve charge

Change in premium or reserve charge have a larger impact then to the recoverable charge due to the covariance adjustment

  • Changes to small risk charges have a small impact on the total risk charge

Annual cost: Ceded Premium \(\times\) Profit Margin

Issue Surplus Notes

Annual cost: (Surplus note yield - Bond yields) \(\times\) Face Value of Surplus Note

However surplus note is a longer commitment as they can not be repaid for a certain time period

Reinsurance might be cheaper and the company can exit quickly